For those hoping bank mergers and acquisitions will explode in 2013 after two underwhelming years … don't hold your breath, advises an Ernst & Young expert.

Consolidation is likely to slightly increase this year, says Nadine Mirchandani, the Americas transaction advisory services leader for the financial services office at Ernst & Young. Economic uncertainty, capital requirements and regulatory issues will continue to suppress activity, she says.

Bank deals rose in number in 2012 but declined in overall value. There were 227 deals worth $13.6 billion last year, compared with 150 deals worth $17 billion a year earlier, according to data from KBW's Keefe, Bruyette & Woods.

The targets involved in 2012's acquisitions are notably smaller than in the precrisis years. Only one deal — M&T Bank's (MTB) bid to buy Hudson City Bancorp (HCBK) — involved a seller with more than $10 billion of assets.

Mirchandani discussed her thoughts on consolidation for the past year and her predictions for 2013 in a wide-ranging interview with American Banker. An edited transcript follows.

How would you describe bank M&A in 2012?
NADINE MIRCHANDANI: We saw a little bit of a surge. Even with that, M&A has been fairly muted in comparison to what expectations were coming out of 2011. It wasn't the consolidation boom that people thought it would be. That's due to a number of reasons. There was through most of 2012 a fair bit of economic uncertainty. There was the election that created uncertainty around regulatory issues. Uncertainty is a never a good thing for mergers and acquisitions.

The whole-bank deals were predominantly for institutions less than $1 billion. Where the transactions are happening is certainly at the smaller size range of the marketplace. There was only one deal where the target was larger than $10 billion and that was Hudson City. From 2003 to 2007 there were six deals per year, for example, with targets greater than $10 billion.

Are we going to see fewer deals in that larger size range?
Capital adequacy is really driving a bank's ability to execute a strategic plan for both organic and inorganic growth, but particularly around M&A it really comes down to the capital you have available. You have to go through the analysis of your balance sheet and say what are the stress scenarios and then determine what kind of excess capital you have to put into play. That's the way the regulators are looking at things and how boardrooms are assessing their appetite for transactions.

In addition to shareholders and management, that regulatory seat at the table is powerful. Banks are certainly making sure their analysis is based on a strategic rationale in terms of accessing a market that is consistent with their geographic or customer strategy.

What are your expectations for bank M&A in 2013?
The environment will continue to be a challenging one to get deals done. There are absolutely opportunities for transactions and the bid-ask spread between buyers and sellers has narrowed a little bit. We've certainly seen quality of the balance sheets of the target banks and the credit exposure are highly correlated for the premium paid. It goes back to that capital question.

I don't think it will be a day one boom. I think we will trend upward slowly. We will remain stable at the pace it was through 2012, maybe some slight uptick toward the latter half of the year as we evolve from a regulatory and economic standpoint.

We've been talking for a while now that there will be a huge boom of M&A activity. But you don't think that is necessarily happening next year.

I think of it as an upward progression in terms of a hill for volume but it will happen. Every couple of weeks there are transactions so there is a steady stream, but it's just at much lower levels than we've expected to see. I think that will continue to be the case. There is a lot absorbing the minds of management as they continue to work through the changing regulatory landscape.

Capital requirements are only expected to increase so there is a bit of caution right now in the system. Hopefully once the fog clears around that we'll see transactions increase.

Can you outline some of the things that need to happen to increase M&A activity?
There are two things — one is strategy and the second is the economics of the transaction. Our clients want to be positioned from a scale perspective in their chosen market as a top player. You'll see transactions unfold in very surgical ways around achieving that scale. Targets that allow certain players to be that will become more attractive. That's where I see the less than $10 billion transactions.

The other piece of the equation is the economics of the transactions. Those institutions that have gone a long way to remediate and to address their balance sheet, such that they have a view around a solid tangible book value on their balance sheet that people are in line with — they'll drive the premium in the transaction marketplace.

What will buyers and sellers look like?
Sellers will be those that have geographic concentration that is appealing to the aggregators [and are] in desirable markets but sort of struggling. They could have a book of business that is low interest rate, inefficient loan demand in their small niche area or a lot of competition. They have some struggles of having adequate capital to grow.

The buyers have excess capital to play. They are looking to be a top player in their region or chosen market, and they are looking to consolidate those strong brands that on a standalone basis don't have the scale that they need to have.

The mid-Atlantic, the Northeast and the West continue to be attractive markets. The Southeast is where the number of deals and pricing continues to struggle a bit when you look at percentage of tangible book.

There were several niche deals last year. Do you expect to see a lot of those in 2013? If so, what kind of businesses might be sold?
The entire financial services landscape is restructuring. There is a little bit of decision-making around what businesses should we be in and whether the financial supermarket model works. Anything that is a unit that has some scale but isn't necessarily scaled appropriately, like asset management or insurance or where there is some complexity from a regulatory standpoint, is an opportunity. I think carveouts, or business-line or unit divestitures, are an opportunity.

What about deal complexity? Last year we saw a few deals that were more complex like BB&T's (BBT) purchase of BankAtlantic. Should we expect more deals that are complex and creative like that?
There will always be the more complex transaction. Anything that involves a carveout from a larger institution is complex because you have to deal with separating out the business and standing it up so it can be integrated into the acquirer. You also have to think about bifurcated customer relationships that might reside on both sides of the business being sold and the businesses being retained.

I think the regulators look carefully at those and make sure there is a demonstrated ability to do those types of transactions. And I think it goes back to our discussion of divestiture of niche businesses. It goes to the scale of your organization. I wouldn't say at the community-bank level or the less than $10 billion you'll see a lot of that but between $10 billion and $50 billion they have several business lines and they could be doing some interesting things with those business lines.

What are the biggest 2013 challenges for bank M&A?
The continued focus that many of these executives have around the regulatory agenda and how that impacts their businesses and the uncertainty around the capital requirements will continue to be an inhibitor. It's just consuming a fair bit of the agenda of the C-suite.

The appetite of management and the corporate community to execute on a transaction, which is a challenging event, is another. And there is the uncertainty of how we will evolve through this economic cycle. Will we have a robust recovery? That will affect the value of how people think about certain markets in terms of their interest and desire around risk of a transaction.

What regulatory issues must be resolved to spur M&A?
There is a very significant amount of analytical work that continues to be done on the stress scenarios and the capital executives can deploy to shareholders. Executives are thinking about what will come in the stress scenarios and what Basel III will require from a capital standpoint.

It's also [about the Consumer Financial Protection Bureau] and what consumer sentiment is around for all of the things institutions are doing to drive earnings. It's also [about] more broadly understanding the Dodd-Frank Act and how it affects others, not necessarily banks, in the financial services landscape — how it will change their behavior as counterparties so even if it doesn't affect banks directly, it does affect the ecosystem.

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